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World watches as China economic leaders take stage

Tue, Feb 7 2012

* Eyes on leader-in-waiting Xi for reform clues

* China-watchers hope Beijing picks up pace of change

* Fast growth but nearly a wasted decade for reformers

By Alan Wheatley, Global Economics Correspondent

LONDON, Feb 7 (Reuters) - A new guessing game is about to
begin: will China's incoming generation of leaders show more
courage than the current incumbents in tackling deep economic
imbalances that threaten to bring growth to a sudden stop?

The question, easier to frame than to answer, is critical
for the world economy. China has accounted for about a quarter
of global growth in recent years, yet as far back as 2007
Premier Wen Jiabao characterised the expansion as "unsteady,
unbalanced, uncoordinated and unsustainable". It still is.

The urgency of finding a solution is grabbing attention for
three reasons.

First, fears persist of a crash in the property market -
exhibit A for critics who say China's unprecedented investment
rate of 49 percent of GDP is creating white elephants and
incubating bad loans.

Second, debate has intensified in China about how "vested
interests" - well-connected politicians, bureaucrats and state
firms - are obstructing efforts to put the economy on a more
stable footing and alienating the man in the street.

Third, the men who will chart China's course over the next
decade are stepping out more onto the world stage.

Vice-President Xi Jinping, who meets U.S. President Barack
Obama at the White House next Tuesday, is all but certain to
take the reins of the ruling Communist Party from Hu Jintao in
the fourth quarter and assume his title as state president in
2013. Wen is due to be succeeded by Vice-Premier Li Keqiang.

Eswar Prasad, a scholar at the Brookings Institution in
Washington, believes the new leaders will want to correct the
imbalances in the economy but will not attempt drastic changes
until they have solidified their political base.

Senior bankers, for example, can be expected to put up
fierce resistance to any attempt to compete away the plump
margins they enjoy because of a state-mandated spread between
deposit and lending rates.

"The system as it is structured works very well for those in
positions of power," said Prasad, co-author of a new pamphlet on
the role of the yuan in the global monetary system.

"But once they have gone through cementing their political
position and once the external environment improves, I expect
the new leadership will push forward much more aggressively with
domestic reforms, including financial sector reforms, that are
essential to rebalance the economy," Prasad said.

LOST DECADE

Just how badly Hu and Wen have dragged their feet on
rebalancing is the underlying theme of a book by another
prominent U.S. China-watcher, Nicholas Lardy of the Peterson
Institute for International Economics in Washington.

Lardy argues that since 2004 reforms have been "anaemic",
ranging from "cautious and incremental to non-existent".

In other words, for all its stellar growth, China is closing
in on a lost decade of reform.

If anything, the imbalances have got worse in the past five
years because Beijing has failed to overcome opposition to key
reforms such as freeing up the exchange rate, decontrolling
interest rates, curbing energy subsidies and requiring
state-owned enterprises to pay dividends into the central
budget.

The result is a significant misallocation of resources that
contributes to a situation in which wages account for a low
share and profits a high share of national income.

In turn, low household disposable income depresses
consumption, while artificially low interest rates force
households to salt away even more cash or invest in property to
meet their savings targets.

And an undervalued exchange rate funnels too much of China's
cheap capital into manufacturing, keeping the external surplus
high.

"The longer the currency remains undervalued, the longer the
allocation of investment resources will remain distorted and the
greater the ultimate costs of economic rebalancing will become,"
Lardy writes in 'Sustaining China's Growth After The Global
Financial Crisis'.

VESTED INTERESTS

Even if the new leaders are more reform-minded than their
predecessors, they will need at least a year to establish their
authority, Lardy believes.

"So the risk is that China will continue for another two or
more years on the path of slow incremental economic reforms that
are not aggressive enough to result in economic rebalancing," he
argues.

Michael Pettis, a professor of finance at Peking University,
believes policymakers will have to actively consider
privatisation within two or three years as a means of
redistributing income and wealth away from the state sector to
households.

He said he had been struck by the growing number of
commentators within China who see the rigidities of the state
system as an obstacle to future economic and political growth.

"Their main concern seems to be over the constraints these
special interests impose on further Chinese development, with
the entrenched interests that have benefited over the last
decade or two having become so powerful that they are making it
increasingly difficult for China to adjust," Pettis wrote in his
newsletter.

Will Xi and Li take on these entrenched interests or be
captured by them?

"Cutting through this morass of interests and fears is not
easy - but the success of the 2013-23 administration of Premier
Li Keqiang will depend upon it," according to Stephen Green,
Standard Chartered Bank's chief China economist.

In China's opaque politics, working out just who is
advocating or resisting this or that reform is a thankless task,
even for close observers such as Green.

In a report commending Lardy's book, he agreed that central
government politics were to blame for the lack of reform but
craved more detail about the people and mechanisms at work.

"Maybe one day, when the State Council archives are opened
up, we will understand more about how the decision-making
process changed from the reform-intense 1990s to the
reform-timid 2000s. Was it fear, money, bureaucratic
in-fighting, or just that the leadership was too occupied with
fighting fires?" Green asked.

Thomson Reuters journalists are subject to an Editorial Handbook which requires fair presentation and disclosure of relevant interests.

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